Purchasing Power Parity and Half Life: Another Look
Gil Kim, Yoonbai Kim

Abstract
In this paper, we investigate the long-run mean reverting behavior of the real exchange rate with its six different definitions for 27 economies using annual data from 1974 to 2003. We find that PPP holds better and the half-life of the real exchange rate is shorter when the wholesale price index rather than consumer price index is used as price level measure. Somewhat surprisingly, there is no evidence that PPP holds better with trade-weighted real exchange rates than with bilateral ones regardless of the price index used. Strong evidence for PPP emerges only with the use of Im, Pesaran, and Shin (2003) panel tests but not with the Levine, Lin, and Chu (2002) test. The estimated half-life varies with the definition of the real exchange rate and is 2 to 3 years, which is shorter than the consensus view.

Full Text: PDF